Finding the hidden costs in
broken supply chains
With tariffs at 30-year lows, what’s really holding up
cross-border trade?
By Mark Gottfredson
Mark Gottfredson is a partner with Bain & Company based in Dallas and a
senior member of Bain’s Performance Improvement practice.
Copyright © 2013 Bain & Company, Inc. All rights reserved.
Finding the hidden costs in broken supply chains
For decades, governments and companies around the
world have focused almost exclusively on tariffs as
the biggest impediment to global trade. Despite tariffs
dropping to a 30-year low, reform efforts have stalled
in recent years and international trade remains seriously
constrained. A big reason: The inefficiencies and chokepoints that hobble the global supply chain turn out to
be a much bigger factor than government-imposed
tariffs in restricting the flow of goods and services
across borders.
they want to truly unlock the economic potential of
global trade. For companies looking to take advantage
of international markets, the message is more immediate: Making the right choices about where and how
to deploy assets globally requires a full understanding
and analysis of how these supply chain barriers affect
return on investment. Failing to anticipate the costs and
risks involved can wipe out the business advantages of
sourcing, operating or selling in foreign markets.
Strengthening supply links
Together with the World Bank, Bain & Company has
analyzed the business implications of supply chain
barriers—everything from border delays and inconsistent product regulations to poor infrastructure and
rampant corruption—presenting our findings in a
report for the World Economic Forum. Our analysis demonstrates that reducing even a subset of
these obstructions could increase global GDP over six
times more than removing all tariffs (see Figure 1).
Supply chain barriers include anything that obstructs
the easy movement of goods from one link in the supply
chain to the next: subpar roads, outmoded border policies, restrictive local-content rules. Their effects vary
by region, industry and country, but the report found
that they often work in concert to slow down trade and
drive up costs in both developing and developed nations.
That drains resources that might otherwise be used to
create jobs and increase prosperity.
That has broad, long-term implications for policymakers,
suggesting that governments need to refocus their
efforts on creating efficiencies in the supply chain if
Many corporate leaders know of these chokepoints from
direct experience. One diversified chemical company
Figure 1: Reducing supply chain barriers has a larger effect than removing tariffs
Increase in trade* and GDP (US $ trillion)
$3
$2.6
2
$1.6
$1.5
4.7%
1
$1.1
$1.0
14.5%
2.6%
9.4%
$0.4
10.1%
0.7%
0
Ambitious scenario
Modest scenario
Tariffs
Countries improve halfway to
global best practice
Countries improve halfway to
regional best practice
All tariffs removed globally
The GDP effect of reducing supply chain barriers is much higher than for tariffs
GDP
Trade
*Based on export value; includes only the effect of “border administration” and ”telecommunication and transport infrastructure.”
Source: Ferrantino, Geiger and Tsigas, The Benefits of Trade Facilitation—A Modelling Exercise. Based on 2007 baseline.
1
Finding the hidden costs in broken supply chains
that exports acetyl and other products to the US, for
instance, needs approvals for every shipment from as
many as five different US regulatory agencies, delaying
30% of inbound shipments and causing cancellations
from customers fed up with waiting. A global food products company sources a significant amount of its raw
materials from Brazil. But a combination of poor roads
and shoddy communications infrastructure slows shipments and makes them difficult to track, increasing
security risk. At port, cargo “dwell” time averages five
to 10 times longer than in Chile and developed nations.
That drives up operating costs and forces the company
to stockpile inventories, tying up working capital.
of payments to the government. Developing nations,
in particular, stand to benefit from improvements. So
too would small and midsize companies, many of which
are blocked from selling internationally by prohibitive
supply chain barriers that strain their limited resources.
Getting past the tipping points
While tariffs can generally be eliminated with the stroke
of a pen once political obstacles are addressed, eliminating
supply chain barriers is a complex task requiring coordinated policy action and investment. As with tariffs,
regulators have to deal with reluctance from companies
and local industries protected by supply chain barriers.
And they have to make smart choices about which
changes will have the greatest impact.
Supply chain barriers fall into four main categories—
market access, telecom and transport infrastructure,
border administration and business environment. We
identified global best practices for each category based
on case studies, calculated what a country’s deviations
from those standards cost it in terms of lost trade and
lower GDP and compared that to the effect of eliminating all tariffs.
Real improvement depends on achieving specific “tipping
points” of new efficiencies across various kinds of barriers that encourage companies wary of wasting resources
to risk new investments in a given market. For example, if the market’s supply chain barriers add 10% to a
company’s cost of doing business there, reducing those
barriers to just 2% won’t likely spur on new investment
activity. But the research shows clearly that once those
tipping points are reached, the impact on trade and foreign investment can be dramatic as companies move to
take advantage of newly opened markets and pathways
to increased growth.
The results were startling. Data showed that if countries
could reduce just two of the supply chain barriers—
border administration and telecom/transport infrastructure—halfway to their global best practice levels,
global GDP could rise by nearly 5%, or $2.6 trillion,
while trade could improve almost 15%. By comparison,
eliminating all import tariffs could increase global GDP
just 0.7%, while boosting trade by 10%. Even if countries
were able to reduce barriers halfway to less aggressive regional best practice levels, global GDP could
rise by 2.6%—still outpacing the benefit from tariff
elimination.
Consider the results of a pilot program initiated by
eBay, the global online commerce platform. In many
ways the Internet has created vast new low-cost opportunities for eBay sellers to connect with previously
inaccessible customers around the world. But when
eBay surveyed its merchants—most of them small
businesses—it found that the opportunity to sell internationally was too often going unrealized. Efforts to
develop all but the most accessible foreign markets are
still inhibited by complex regulations, poor international
shipping services and high fixed costs, meaning merchants with narrow resources could risk doing business
in only a limited number of foreign markets.
The efforts to eliminate tariffs remain an important
area of focus for governments. But a coordinated push
to free up supply chain chokepoints will give policymakers significantly more leverage to increase economic
growth through free trade.
How? While both supply chain barriers and tariffs
increase the cost of trade, barriers create greater inefficiencies than tariffs because they often represent a
pure waste of resources rather than a simple transfer
Responding to the problem, eBay set up a pilot program
to help eliminate the barriers. For a pre-selected group
2
Finding the hidden costs in broken supply chains
can countries but far longer than comparable supply
routes in Asia.
of merchants it made listings available to a global customer base and then undertook steps to ease reluctance
among both buyers and sellers by providing full
transparency on what it would cost to ship goods
and when they would arrive. It worked through
shipping issues and facilitated communication
among people who spoke different languages. Preliminary results indicate that making these improvements could lead to a 60% to 80% increase in crossborder activity among these Internet-enabled small
businesses. Given the global importance of small
companies in terms of job creation and economic
activity, the broad benefits of such an increase in
trade activity would be substantial.
These supply chain costs completely offset Madagascar’s
labor-cost advantage and undermine the company’s
ability to compete in segments of the “fast-fashion”
business, where speed to market is crucial. Producing
some apparel in Madagascar makes sense because the
company can ship tariff-free to Europe and compete
with Asian producers that still face duties—a reminder
that tariffs do still matter. But if those tariffs disappeared,
Madagascar would not be competitive.
The message is that supply chain barriers can significantly
upset conventional cost and revenue calculations. Most
companies involved in cross-border trade have become
expert in standard return-on-investment analysis to justify investments abroad. They know how to evaluate
tax breaks, labor costs, capital expenses and the costs
associated with logistics, sourcing equipment and finding
raw materials. But often these traditional analyses fall
short when it comes to capturing the true cost of doing business.
What companies can do right now
While governments can help reduce supply chain barriers,
companies can’t afford to wait. As a business matter,
they must make investments in their global operations
right now to remain competitive. Recognizing the
importance of “hidden” supply chain costs, the leading
companies are incorporating more rigorous due diligence into their decisions about where to produce and
sell their wares. For executive teams, the report’s findings offer important insights on key areas to consider
when analyzing the true costs of doing business in a
particular country or region.
Breaking down the costs
Over the years, Bain has worked with many companies
weighing the merits of trading with Mexico or moving
production there, especially after the North American
Free Trade Agreement ended most formal trade barriers
on the continent. While a traditional analysis might show
that Mexico has a 25% cost advantage relative to the US
and Canada, more than half of that advantage could be
eliminated by supply chain friction costs. In doing the
analysis, we’ve been able to quantify those costs and
how they affect a company’s real return on investment.
Even large companies often fail to anticipate the costs
and risks imposed by supply chain barriers. No central
data bank exists that can tell an executive team how long
its products are likely to be delayed at a given border
or what the average speed of trucks is along a specific
shipping route or transport corridor. Yet leaving barrierrelated costs out of the equation could open companies
to hidden costs that significantly erode returns.
The benefits of investing in Mexico are well known. A
hypothetical manufacturer weighing whether to relocate
production capacity there would see that hourly wage
rates are about one-fifth of what they are in the US, while
capital expenditures related to building facilities are
typically 10% lower than in the US or Canada.
One apparel company established operations in Madagascar, for instance, only to find that supply chain barriers seriously limited its opportunity there. The company was initially attracted by the country’s low labor
costs and proximity to high-quality African cotton suppliers. But its products are frequently delayed at the border
and moving finished goods the 330 miles from mill to
port takes 14 hours—not bad compared with many Afri-
Depending on the company’s product mix, there can
be other advantages as well. Products best suited for
3
Finding the hidden costs in broken supply chains
production in Mexico are those with the highest level
of direct and indirect labor content. They are made from
basic materials that can be easily sourced in Mexico.
And because those materials have to travel long distances
to market, they are typically nonperishable (to avoid
the cost of refrigerated trucks) and have a high valueto-weight ratio.
might require the investing company to take extraordinary measures to safeguard building assets as well as
goods in transit—putting armed guards on all trucks,
for instance. Security measures alone can boost fixed
costs by as much as 7% per year.
Clearly, many companies have profitable operations in
Mexico and it might make sense for our hypothetical
manufacturer to establish a beachhead there as well. But
the key to any such decision is to take a full accounting of all the relevant cost inputs, while extrapolating
the consequences of supply chain inefficiencies: Will
delays force a company to stockpile buffer inventories,
which tie up working capital and add to direct costs such
as warehousing? If so, what risks follow on in the form
of depreciation, spoilage or production bottlenecks?
Even if those considerations support a positive investment
conclusion, however, a number of hidden costs complicate
a more thorough analysis (see Figure 2). Mexico’s lack
of federal and provincial tax breaks, for instance, can add
1% to investment costs up front. The lower productivity
of Mexican hourly workers coupled with a lack of automation means a company might have to boost staffing
levels 25%, erasing some of the labor-cost advantage.
When these costs are factored in, return-on-investment
cost calculations will be adjusted upward to reflect the
level of risk anticipated. But companies often fail to take
these costs into account; as a result they find themselves locked into uneconomical production and marketing decisions.
Transporting goods in Mexico is also a problem. Gaps
in road and rail connections require shipments to
travel extra distances that will eat into margins. And
while Mexican trucks entering the US no longer have
to switch drivers and cabs as they did until 2011, they
do have to buy US insurance at the highest possible
rate. Then there’s safety. High crime rates in Mexico
Figure 2: Producing in Mexico has hidden costs that companies must recognize
Manufacturing facility costs
(indexed to US costs)
Net benefit of 9%
1.0X
1.00X
Initial view suggests
Mexico is 25% cheaper
0.8
0.16X
0.91X
Barriers
0.75X
0.6
Border administration,
inadequate infrastructure,
reduced availability of local suppliers,
security and lower productivity labor
increase the cost 16%
0.4
0.2
0.0
US
Mexico
(based on labor and capital expenditure)
Note: Hypothetical example based on Bain experience
Source: Bain & Company
4
Supply chain barriers
Total cost of Mexico
Finding the hidden costs in broken supply chains
The high price of success in Africa
costs are high, but controlling production yields the
lowest-cost finished goods. To protect itself, the company requires that any such full-scale investment have
an expected return of 25% to 50% and a payback period of less than four years.
One consumer products company operating in Africa
demonstrates that it is possible to take advantage of
market opportunities in countries plagued by supply
chain problems—as long as decision makers remain
intently focused on mitigating the high risks and costs
those barriers impose.
Where to look for “hidden” costs
Clearly, supply chain barriers to trade are both complex and widespread. A more comprehensive approach to foreign investment decisions means recognizing costs in four important categories of the supply
chain (see Figure 3) . Executive teams can begin
by asking some key questions relating to each category:
Africa is fraught with complexity for foreign companies
hoping to capitalize on its strong growth potential. The
continent is rife with political and social instability,
economic mismanagement, mercurial regulatory regimes
and persistent security concerns. A lack of services and
shoddy transportation infrastructure create massive
inefficiencies that drive up prices. “Facilitation payments” can speed shipments through borders and ports.
But for those unwilling to participate in this so-called
“soft corruption,” even more severe delays can result.
Market access
A global packaged goods manufacturer has experienced
the worst of many of these supply chain barriers. Civil
unrest in Nigeria has brought its operations to a temporary halt in the past. Sudden currency depreciations
have cost it millions overnight. In historically unstable
markets like Zimbabwe and Malawi, the inability to trust
credit agreements means business is done in cash. That
constrains investment and inhibits growth.
•
Do you know how many regulatory agencies you
have to deal with as you move goods into or out of
your chosen market?
•
Do you have a list of the licensing regulations that
apply to your product or service?
•
Are there preferential rules or regulations that give
local companies a leg up in the market? Will that
affect your costs or competitiveness?
Border administration
But because the company sees real value in selling its
goods in these rapidly developing markets, it has devised
a strategy for dealing with the uncertainty that involves
categorizing African markets by their risk profiles and
tailoring its approach case by case. Depending on conditions, the company weighs three different options for
building its market presence.
In high-risk countries, for instance, it imports finished
goods only. That means higher landed unit costs due to
increased inventory and freight expense. But the tradeoff is decreased financial exposure and risk. In more
stable countries, the company eliminates some of these
costs by contracting with local manufacturers, though
that still means sacrificing economies of scale. The
third option is producing its own goods onshore, a
strategy reserved for the least volatile countries. Initial
•
What percentage of shipments will be inspected
at the border, on average? How does that compare
with other markets?
•
What is the typical delay time at a particular border
or port, and what will that cost in terms of spoilage,
theft or the need to stockpile additional inventories?
•
How often do border officials demand “facilitation
payments” to move goods efficiently? Are you prepared for the repercussions of not paying (i.e.,
potentially severe delays)?
Telecom and transport infrastructure
•
5
Does the country have an electronic system at the
border allowing shippers to declare goods in advance,
Finding the hidden costs in broken supply chains
Figure 3: Companies should take a comprehensive approach to supply chain decisions
Consequence
Barrier
Factor costs
Costs
Increased
operational
costs
Increased
investment/
working
capital
Delay
Increased
average
delay
Increased
variable
delay
(unpredictability)
Volume
Risk
Decreased
volume
Increased
(political)
risk
(unpredictability)
Domestic and foreign
market access
Barrier costs
Efficiency of customs
administration
Efficiency of import-export
procedures
Transparency of border
administration
Compare alternatives
Availability and quality of
transport infrastructure
Availability and quality of
transport services
Availability and use of ICTs
Strategic implications
Regulatory environment
Physical security
Source: Bain & Company
speeding up processing? Are those systems reliable
and used consistently?
•
How fast on average are trucks or rail shipments
able to move to and from key ports? What are the
common delays and how costly are they?
•
What special fees, licenses or other special regulations
do local authorities impose on truckers that add costs
or slow the movement of goods?
All of these costs can be estimated to gauge the effect on
potential investment returns. But if your team can’t provide definitive answers to questions like these, moving
forward can have real repercussions. In Brazil, for instance, an attempt to build an electronic freight-invoicing
system should have helped speed shipments. Instead,
subpar government information and communications
technology (ICT) systems couldn’t handle the volume and
often crashed, causing longer delays than the old system.
Border regulations that affect efficiency also vary widely:
An express delivery company estimates that inspection
rates on its shipments range from 2% in the Netherlands
to roughly 10% in Mexico. A pharmaceutical company
that has won “trusted trader” status in both China and
Canada finds that Canada’s streamlined system gets
goods on their way quickly while China’s cumbersome
procedures cost the company six times as much due to
delays and related expenses.
Business environment
•
What are the political and administrative realities
in your chosen market, and how will that affect the
ease and security of doing business there?
•
Do businesses enjoy the support and encouragement
of government officials, or is there a history of random taxation, excessive fees or other attempts to
extract value from the private sector?
•
When it comes to business environment, developing
countries can often promise as many barriers as opportunities. As the consumer products company doing
business in Africa has found, security concerns and
Are the rules and regulations that pertain to your
business clear and consistent? Are there established
procedures for working through them?
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Finding the hidden costs in broken supply chains
efforts to cope with a highly disruptive sociopolitical
environment often create a cascade of costs that can
upset even the most carefully considered investments.
Conditions are more stable in China, but one large semiconductor manufacturer reports that it constantly wrestles
with various rules that are vague and inconsistent. Struggling to comply with them can often lead to confusion
and delays.
impact business. A reliable assessment of what it truly
costs to operate in a given market is the necessary foundation for the next step in evaluating foreign investment:
comparing alternatives and deciding which best suit a
company’s long-term strategy and business objectives.
Global trade has increased sharply over the past 30
years, and the opening of markets long considered inaccessible has created rich opportunities for companies of
all sizes in every industry. But the companies that get
it right are the ones that can best identify and analyze
the real cost of capturing those opportunities and avoiding the mistake of going in unprepared.
For every company and industry the supply chain challenge
is different. But all share the need to recognize potential
barriers where they are most likely to be encountered
and to develop a full understanding of how they will
Calculating the biggest barriers in trade
Economists and executives have known for a long time that supply chain barriers are real. But the
full scope of their corrosive effect on global trade and prosperity emerges when a quantitative model
is combined with on-the-ground case studies showing how companies actually think about their supply chains and how that affects their decision making.
Many studies have measured the macroeconomic effect of supply chain barriers. But most lack insight
into how those issues affect corporate investment and strategy. By augmenting their analysis with
18 detailed “real-world” case studies, Bain & Company, along with economists from the World Bank,
the World Economic Forum and the US International Trade Commission, were able to gain those insights,
leading to a set of policy recommendations aimed at breaking down impediments to action.
The study identified four broad categories of supply chain barriers—market access, border administration,
transportation and telecom infrastructure, and business environment. Researchers focused on the two
that have the most immediate upside, border- and infrastructure-related barriers, building models to
measure the impact of these barriers on GDP by region and comparing the results to the effects of
eliminating tariffs. They used the case studies representing major industries, barriers and supply chain
steps to illuminate real problems and estimate how improvements in these categories would affect behavior.
The study shows plainly that policies to improve border administration and infrastructure could have six
times the impact on global GDP as the elimination of all tariffs, largely because improvements would
eliminate so much of the waste and inefficiency that hobbles growth. But the data also suggest that
improvements could be even more dramatic: If policymakers could forge improvements across all
four of the barrier categories, the positive effect on GDP would be approximately 70% higher.
7
Finding the hidden costs in broken supply chains
Key contacts in Bain’s Performance Improvement practice:
Americas:
Greg Gerstenhaber in Dallas (greg.gerstenhaber@bain.com)
Mark Gottfredson in Dallas (mark.gottfredson@bain.com)
Lee Delaney in Boston (lee.delaney@bain.com)
EMEA:
Niels Peder Nielsen in Copenhagen (nielspeder.nielsen@bain.com)
Asia-Pacific:
Gerry Mattios in Beijing (gerry.mattios@bain.com)
8
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